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Chapter 12 Test Bank – Static Key
1. Capital budgeting decisions involve a minimum time horizon of five years.
2. A good capital budgeting program requires that a number of steps be taken in the decision-making
process. The first step is the explanation of data.
3. Possibly the most overlooked part of the capital budgeting process is the search for new opportunities
through innovation and creative thinking.
4. In most capital budgeting decisions, the emphasis should be on reported earnings rather than cash
flows.
5. Even though one project may have superior cash flows, top management may sometimes choose a
project that inflates earnings instead of cash flow.
6. The first administrative consideration in any capital budgeting process is collection of data.
7. It is not unusual for a corporate president to be as sensitive to after-tax income rather than cash flow.
8. Capital budgeting is only a concern of finance and accounting personnel.
9. We add depreciation to net income to arrive at a true earnings picture.
10. The payback method is very basic but it gives the user an understanding of when the cost of the initial
project will be completely paid off.
11. The payback method is not really a theoretically correct approach.
12. A rapid payback may be important to firms having rapid technological development.
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13. Using the payback method can be appropriate when the time value of money is considered.
14. Depreciation is important in calculating projected cash flows because it lowers the profits, but does not
affect the cash account.
15. To find the exact internal rate of return for projects with uneven cash flows, we can interpolate between
two factors from the time value of money table: present value of a $1.
16. With non-mutually exclusive events and no capital rationing, we will usually arrive at the same
conclusions using either the net present value or internal rate of return methods.
17. The internal rate of return is the interest rate that equates the cash outflows of an investment with the
subsequent cash inflows.
18. The net present value primary advantage over the internal rate of return method is that it does not
require the time value of money calculations that the internal rate of return requires.
19. Non-mutually exclusive alternatives can be accepted at the same time.
20. The selection of a mutually exclusive project means that all other projects with a positive net present
value may also be selected.
21. The profitability index is calculated by dividing the project’s net present value by the present value of
the projected cash outflows.
22. It is the difference in the reinvestment assumptions that can be significant in determining when to use
the net present value or internal rate of return methods.
23. Under the net present value method, cash flows are assumed to be reinvested at the firm’s weighted
average cost of capital.
24. For high-internal rate of return investments, it is perfectly acceptable to assume that reinvestment will
occur at an equally high, if not higher, rate.
25. The modified internal rate of return method assumes that inflows are reinvested at 80% of the internal
rate of return.
26. Under capital rationing, a firm will maximize profitability.
27. The net present value profile allows a firm to examine the project’s net present value over time without
any adjustments.
28. The net present values’ weakness is that it does not provide a decision for mutually exclusive
investments.
29. When using accelerated depreciation, the present value of future cash flows increases.
30. Under the “modified accelerated-cost-recovery system” (MACRS) of depreciation, cash flow tends to
decline with the passage of time.
31. Although firms can elect to use straight-line depreciation for their external financial reporting, the
MACRS depreciation schedules have exceeded in use over other depreciation methods for tax purposes.
32. In most cases, asset lives are shorter under MACRS depreciation than they would be with straight-line
depreciation.
33. Most real estate property is depreciated over a 10-year period.
34. For a small business, it is possible for the purchase price of an asset to be expensed rather than
depreciated.
35. Under MACRS depreciation, taxes paid in the first year of an asset’s life are subtracted from the base
used to calculate depreciation expense.
36. Under MACRS depreciation, there are no tax credits for the purpose of calculating the base for
depreciation expenses.
37. Under MACRS depreciation, the tax life of an asset and its economically useful life are assumed to be
the same.
38. If an asset is sold for a price above its book value, the difference is considered taxable income to the
firm.
39. A tax loss on the sale of a depreciable asset used in business or trade may be written off against
income.
40. In a replacement decision, a book loss on an old asset can be a valuable feature.
41. The dollar amount of losses incurred when an old asset is sold below book value is added to the
purchase price of a new asset in calculating the base for depreciation.
42. Cash flow is used for a net present value analysis, while earnings are used for the internal rate of return
and payback analysis.
43. When net present value and internal rate of return analysis provide inconsistent rankings of projects,
the financial manager should generally move forward with the project that has the highest internal rate of
return.
44. Investors discount the later years of a long-term project at a lower rate because they are generally less
precise.
45. It is more likely for financial managers to focus on cash flow and corporate executives to focus on
earnings of the company.
46. Capital rationing is generally a positive action for a firm because it prevents rapid growth, which can
drive up the cost of capital.
47. The reinvestment assumption is a downside of the internal rate of return method of analysis because it
assumes that cash flows are reinvested at the cost of capital.
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48. In a general sense, “cash flow” can be said to equal
49. The reason cash flow is used in capital budgeting is because
50. The first step in the capital budgeting process is
51. Capital budgeting is primarily concerned with
52. An appropriate capital budgeting process requires that the following steps be taken in which order?
a) Collection of data
b) Re evaluation and adjustment
c) Evaluation and decision making
d) Search for and discovery of investment opportunities
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53. Assume a corporation has earnings before depreciation and taxes of $82,000, depreciation of $45,000,
and that it has a 30% tax bracket. What are the after-tax cash flows for the company?
54. Assume a project has earnings before depreciation and taxes of $15,000, depreciation of $25,000, and
that the firm has a 30% tax bracket. What are the after-tax cash flows for the project?
55. Which of the following is not a time-adjusted method for ranking investment proposals?
56. Which of the following statements about the “payback method” is true?
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57. There are several disadvantages to the payback method, among them:
58. The payback method has several disadvantages, among them:
59. Assume a $6,500 investment and the following cash flows for two alternatives.
Under the payback method, which of the following could be concluded?
60. The Dammon Corp. has the following investment opportunities:
Under the payback method and assuming these machines are mutually exclusive, which machine(s) would
Dammon Corp. choose?
61. Suppose that interest rates (and, therefore, the firm’s weighted average cost of capital) increase. This
WOULD NOT CHANGE the capital budgeting choices a firm would make if it
62. You buy a new piece of equipment for $7,360, and you receive a cash inflow of $1,000 per year for 10
years. What is the internal rate of return?
63. You require an internal rate of return of 8% to accept a project. If the project will yield $10,000 per year
for 10 years, what is the maximum amount that you would be willing to invest in the project?
64. How would the salvage value be treated in a net present value calculation?
65. The longer the life of an investment